Selling a House to Family and Capital Gains Tax

by Cynthia in Dayton, Ohio and by Charles in Girard,Ohio

Ask Kate about Selling a House to a Relative: Cynthia would like to sell a house that she's recently inherited to her niece. But she's concerned how much capital gains tax she will owe after gifting the down payment. The problem is, no one can tell her how to calculate the tax. Additionally Charles writes me for tips on refinancing a land contract that needs paying off.

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Capital Gains on a Gift of Equity

By Cynthia in Dayton, Ohio

Hi Kate,

My siblings and I inherited a house from my parents. My niece and her husband are interested in buying it.

But they're just starting out and don't have a 20% downpayment to avoid the PMI.

The realtor has suggested raising the selling price 20% above what we agreed to sell it to them for and then give them a 20% gift of equity they can use as the downpayment.

The inflated selling price would still be slightly below current appraisal. The actual price we agreed to sell it for, which is what we would actually receive from the house, is less than the death value of the house (our cost basis). But raising the price to accommodate their PMI would put it above the death value.

My question is: is capital gains tax calculated on the raised selling price, since that's what would be on their loan documents, or is it based on the amount we would actually receive?

I think it's based on the higher official selling price, my niece's husband thinks it's based on the lower price since that's what we'd actually get from the house.

But I've seen answers both ways, one of which referenced section E of IRS Regulation sec. 1.1001-1(e) which talks about the amount received being taxed. I don't know that this really applies though as it talks about transferring property and never uses the word selling.

On another tax site I found an example where the 'tax expert' said it would be based on the higher price on the loan documents. Thanks.

To calculate the gain or loss on the sale of a main home, the IRS expects that you understand the meaning of the selling price, the amount realized, and the adjusted basis.

Easy? No! And we wonder why everyone has a different opinion on the calculation! To complicate matters further, the real estate is part of an inheritance and not your main house.

Real Estate Sales Tax

Additionally, whether or not this is termed a sale, the lender will require that the title be transferred to your niece and her husband. In many states, there is an associated sales tax charged to the seller (unless the transfer occurs between spouses) when property is sold.

Gift Tax on Gifted Down Payments

Speaking of taxes, do you know if the IRS gift rules apply since you will be gifting equity to your niece for her down payment?

Capital Gains Tax, Real Estate Sales Tax, and Gift Tax Questions

I realize instead of answering your initial question about capital gains tax that I am raising more questions and pointing out that you could possibly have even more unexpected expenses. So, I strongly recommend that you consult a Certified Public Accountant familiar with real estate for accurate IRS information.

You may also need to call your local title company to verify the existence of real estate sales tax in Ohio and the estimated amount you could incur.

Non-Arms-Length Transactions

One more thing. When real estate is sold between family members, the sale is classified as a non-arms-length transaction. Many lenders shy away from these transactions. Read more about this at Tips and Help for Non-Arms-Length Transactions.

Best wishes,

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Refinancing a Land Contract

By Charles in Girard,Ohio

Hi Kate:

I have been living in this home for 3 years financed on a land contract. I've made monthly payments every month.

I've recently tried to get new financing from several companies who say I have to make more money and don't have enough credit.

While these inquiries have pulled down what credit score I have, the problem is that there's no place to go, not enough money to move, and seems no one cares!

Hopefully, you are not under immediate pressure to pay off your land contract. Assuming there is not a looming balloon payment, here are steps I recommend taking.

1. Create a Land Contract File

Because most land contracts are not recorded, make it easier for your lender to arrive at a more favorable decision by supplying the written terms and payment history pertaining to the contract. Gather these items...

Signed land contract, all pages.

Copies of the checks written to pay the land contract and corresponding bank statements.

Name, address, phone number of the holder of the land contract.

2. Establish New Credit

Here is how to begin establishing new credit without going into debt.

Apply for a secured credit card.

Use it only to buy necessities.

Pay the balance in full each month.

Tip: When comparing offers, look for secure credit card terms that do not charge interest as long as the balance is paid in full each month.

3. Shop for Experienced Lenders

Not all lenders are create equal! So shop for one who is experienced in paying off land contracts. Feel free to ask them to describe solutions to similar transactions that they've handled in the past.

As you shop for lenders, see if they'd be more willing to refinance your home if the holder of the land contract agreed to carry back a 10% second mortgage.

In doing this, part of the risk is shifted off the lender which makes them more accommodating. Although the land contract holder would not be fully paid off, he or she would receive 90% of the balance.

You would have two house payments, the primary one to the bank and a smaller one to the seller. But hopefully you could get the seller paid off in a few years and be left only with the bank loan.

Kate's Tips

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